Agency warns of 'formidable fiscal challenge'

The huge size of the deficit projected for 2011 - currently forecast at £163 billion in April's Budget - was "striking" in contrast with the increased belt-tightening efforts of other European nations, it added.

The warning dented the pound against the dollar and comes as Prime Minister David Cameron heralds "painful" spending cuts affecting the lifestyles of everyone in Britain over the coming years.

"The scale of the UK's fiscal challenge is formidable and warrants a strong medium-term consolidation strategy - including a faster pace of deficit reduction than set out in the April 2010 Budget," Fitch said.

The eyes of international markets as well as nervous UK households will be on Chancellor George Osborne's emergency Budget to be delivered in two weeks' time, along with a detailed spending review due to be set out later this year.

Video: Osborne cuts framework

Fitch warned that the recent sovereign debt crisis engulfing Greece - as well as concerns over Spain and Portugal - outlined the need for more credible recovery plans and hinted at the loss of the UK's gold-plated triple-A rating unless further action was taken,

It said Spain, Portugal and Italy had all recently announced additional tightening measures amounting to between 1% and 2% of GDP by 2011 in response to increasing pressure from markets, leaving the UK potentially vulnerable.

"There is a risk that the UK's existing deficit-cutting targets begin to look distinctly weak compared with those of its high-grade peers," the ratings agency said.

The deficit will also remain much higher if the newly-formed Office for Budget Responsibility lowers growth forecasts for next year - which were set by the Treasury in April at an optimistic-looking 3.25%.

A downgraded UK growth forecast will ripple through the public finances, impacting tax revenues and pushing up spending, Fitch said.

If growth is 1% lower than forecast in 2011, the deficit could be around 2% of GDP higher than current predictions by the planned end of the coalition Parliament in 2015, the ratings agency added.

A Treasury spokesman: "Fitch's report makes the case clearly for an acceleration of deficit reduction, particularly in light of events in the euro-area sovereign debt market in recent months.

"The Government agrees and that is why it is committed to significantly accelerating the reduction of the structural deficit."